A number of analysts have suggested that oil prices might crater to $20 a barrel if storage tanks become full, which is certainly a possibility. There is significant uncertainty, but some indicators suggest this may be approaching.

Physical numbers: Storage capacity is not estimated with any accuracy and there is very little data on the amount outside the OECD. The National Petroleum Council used to do occasional studies of U.S. capacity, but hasn’t in a long while. Numbers change with a) pipeline capacity (oil has to fill it up) and b) refinery capacity. But although U.S. refinery capacity hasn’t changed much in decades, the consolidation in the industry has improved the efficiency of inventory management. Shale production has reversed this trend, and U.S. private crude oil inventories are higher than they’ve ever been: in over three decades, they never passed 400 million barrels, and now they are approaching 500.

In the past, non-OECD inventories were estimated by some analysts by taking the level relative to consumption as reported by a 1980s era Shell survey. Then, multiplying current estimates of consumption by the days of inventories in that estimate, an estimate of inventories was generated. This is not data, and involves some major assumptions, especially that inventory patterns don't change.

In 1998, storage was described as being “full,” and some hundreds of millions of barrels were describing as “missing,” meaning they couldn’t be accounted for in the data. (These are now known as “Knappsters” after David Knapp, who coined the term “missing barrels”.) But only in recent months have inventories risen above the earlier ceiling, as the figure shows (million barrels OECD private inventories). While storage capacity has increased, this clearly suggests the world might be nearing full tanks again.

Of course, in relative terms (days of consumption, that is stocks in barrels divided by barrels per day of oil used), OECD inventories have been relatively high since the 2008 financial crisis, but soaring to well above historical highs in recent months, as the figure below shows.

Price impact: The best way to judge the adequacy (or surplus) of storage levels is the contango in the market. The difference between the current price and what people are willing to pay in future months is known as contango (when positive) and backwardation (when negative). A strong contango implies a glut in physical barrels, as it means that buying oil now requires an expectation that future prices will be high enough to cover holding costs. Those costs include the interest rate (since capital is being tied up in the oil) and storage costs, which are the biggest component and can grow rapidly as existing storage fills.

The calculation is complicated by the expectations of future prices, which fluctuate enormously but in the short-term, a sharp increase in contango would be suggestive of an increase in the marginal cost of storage. That is, refurbishing idle tanks or renting a tanker instead of using existing storage. Of course, tanker rates vary but are obviously depressed now given weak global oil demand. Thus, a sharp increase in contango would be a sign that the current supply is in such surplus that inventory holders are having to scramble for high-cost storage.

The market does not seem to have reached that point yet. The figure below shows the 3-month contango since 1995 (as percentage of the current price), and two periods stand out: the financial crisis of 2008 saw the contango soar to 40%, but similarly, the market glut in 1998 reached nearly that level, almost 30%. Current levels of 10% indicate a surplus but not yet full tanks, although the contango is very definitely at the “high” levels.

The thing is that the outlook is for rising inventories over the next six months, when they usually decline in the winter. However, projections for mild weather combined with the return of Iranian oil, perhaps in a few weeks, could exacerbate the existing surplus and see the contango soar, which would also equate to pressure on oil prices. The question then will be: what reaction can be expected from OPEC? At least a 1 mb/d cut in production by no later than the 2nd quarter of 2016 would be necessary to bring prices back above $40.